The key to success in international trade is managing risks and the most crucial risk is payment.
In today’s fiercely competitive global marketplace, exporters are under pressure to offer their customers attractive payment terms in order to make a sale. Negotiations are key to balancing buyer needs and seller payment risks.
Before contract negotiations start, you should consider which of the four primary methods of payment for international transactions is right for you. Each has beneficial or adverse effects on cash-flow, administration costs, and exchange rate risk. Having a clear objective before negotiations start can help secure the payment term that suits you – and your customer – best.
You can avoid credit risk with cash-in-advance payment terms because payment is received before ownership of the goods is transferred. The timing of the payment can be scheduled prior to manufacturing or shipping, but the earlier you receive payment, the greater the cash-flow problem for your buyer. Payment is typically made with a credit card or wire transfer. Insisting on cash-in-advance could put your sales negotiations at risk if your competitors are willing to offer the buyer more attractive payment terms.
Letters of Credit
A letter of credit (LC) is a commitment by a buyer’s bank that payment will be made to you when the bank receives specified documents about the transaction. These documents might include a waybill, a commercial invoice, a packing list, and an insurance certificate, depending on the Incoterm negotiated. The key benefit to having an LC is that it’s normally legally binding and cannot be cancelled unless all parties agree. The bank costs are also paid by the buyer and once you’ve sent the goods, you don’t run a risk of not being paid. Letters of credit are therefore often used in international trade, particularly if reliable credit information about the buyer is difficult to obtain but the seller is satisfied with the creditworthiness of the foreign bank. An LC also protects the buyer as payment only takes placed when the goods have been shipped or delivered as promised.
If you are confident of your buyer’s ability and willingness to pay, you might consider using documentary collection (DC) as a payment method. Put simply, you submit specified documents to your bank, which will hand the documents over when the buyer has either made payment or promised to do so at a future date agreed by you. You retain ownership of the goods until the exchange of documents. DCs are usually less costly than LCs and you stay in control until payment is received. However, there’s limited recourse in the event of non-payment.
An open account transaction is a sale where your goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. This payment term is the most advantageous option for your buyer in terms of cash flow and costs, but it’s also the highest risk option for you. Foreign buyers will attempt to negotiate for an open account with a long settlement date. You can mitigate against the risk of losing sales to competitors by offering an open account but reduce the risk of non-payment through credit insurance or merchant factoring, which is where a third party will make an advance payment of a large percentage of the value of the goods and retain the remaining money when they collect the full amount from your buyer at a later date. This removes the risk to you of non-payment and improves your cash flow.